Tuesday, 13 July 2010

What's Wrong With Progressive Taxation?

Given that ‘progressive’ seems to be the buzzword of the coalition, and that its critics have slammed the rise in VAT as ‘regressive’, it is strange that both supporters and opponents of the government seem to have forgotten about progressive taxation. Progressive taxes are those which fall heavier upon the rich, proportionate to their income. Income tax is the most prominent example – those on higher incomes have to pay a higher rate.

Much of the debate around the government’s response to the budget deficit has focused on its inequity. Cuts to public services and benefits affect the poor more than the rich. Public sector job cuts harm the most vulnerable. The regressive nature of VAT means it is a tax with a disproportionate effect on the budgets of poorer households. Yet few have dared to mention the alternative: raising taxes on the rich.

There are notable exceptions: the political philosopher Martin O’Neill has written in defence of redistributive taxation in the Guardian. Similarly, the IPPR has argued that the excessive focus on government spending and the relative neglect of taxation is “arbitrary”. However, George Osborne maintains that “The country has overspent; it has not been under-taxed”.

This sounds like dogma. The tax burden in the UK today is relatively low, both by international and historical standards. British taxpayers pay considerably less than the OECD average. Similarly, for most of the period under the Thatcher government, the basic rate of income tax was 30%, and the top rate 60%. Today, the basic rate is 20% and the top rate 40% (though this has been temporarily raised to 50%).

However, the left needs to be careful. The right has been criticised for putting ideology before economics in their apparent zeal to dismantle the state. The left (wherever it is) needs to be careful that it is not similarly doctrinaire about taxing the rich. We might hate inequality, and see taxation as an important means of fighting it, but we must be careful not to be vindictive and counterproductive. The potential flaw in O’Neill’s argument is that he assumes that taxing the rich is an effective substitute for cutting spending. But the right may well protest that it is not. Indeed, Osborne believes that economic sense is on his side: “Our approach is supported by the international evidence, compiled by the Organisation for Economic Cooperation and Development, the International Monetary Fund and others, which found that consolidations delivered through lower spending are more effective at correcting deficits and boosting growth than consolidations delivered through tax increases”

There is some truth to this: the economic evidence does support Osborne's claim that spending cuts are more efficient than raising taxes when tackling a budget deficit. Yet the Conservatives are misleading us if they intend us to think that raising taxes is not a practical or feasible alternative. Indeed, in two-thirds of previous efforts at budget consolidation, revenue raising has been more significant than cuts. Indeed, Stephanie Guichard, author of one of the OECD reports to which Osborne alludes, has admitted “in-depth reforms of public expenditure are supposed to produce stronger consolidations, but in practice it can be easier to increase taxes if you want to get quick results”.

It appears, therefore, that there is some economic justification for the coalition’s strategy to cut the deficit. Yet there are at least three grounds for dissent. Firstly, it is not clear that the evidence justifies such an overwhelming bias towards cuts: most adjustments seek a 50:50 ratio between cuts and tax rises; Osborne’s aim is 80:20.

Second, where taxes are being raised, it is unclear that they are the right ones. VAT is rightly condemned as a regressive tax. In a time of stagnant demand, a VAT rise is hardly beneficial for growth. Given how Labour were pilloried for their ‘jobs tax’ (a rise in national insurance), it is odd that so few have picked up on the potential consequences of a rise in sales tax – a tax on economic activity. Of course, progressive taxes such as income tax can have a negative influence on growth too, but this largely depends on the strength of the link between taxes and work incentives, which is far from clear.

Most crucially, though, efficiency is not the only concern. There is nothing stupid or irrational about a society choosing a less economically efficient course if they believe that it is fairer. If it comes to it, many would sacrifice a smaller burden on the poor for a greater burden on the rich.

It is still far from self-evident that this discredits the existing government policy. But it is clear that there is a viable alternative to heavy cuts. What we need is more of a debate about the merits of the alternative.